Learning Business: Comparative Advantage

BY TINA BOUTIS

 
THE SITUATION
Imagine a world with two countries: Easterica and Westasia. To produce 1 mango, Easterica needs 2 workers, and Westasia needs 4 workers.
But, to produce 1 banana, Easterica needs 1worker, and Westasia needs 4 workers.
Which country do you think should produce each product?
WHAT IS ABSOLUTE ADVANTAGE?
To understand comparative advantage, we need to understand absolute advantage. Absolute advantage means that the country who can produce at a lower cost, or with fewer resources should be producing each product. In this case, Easterica would have the absolute advantage in the production of both mangoes and bananas because it takes them less workers to produce each product.
WHAT IS COMPARATIVE ADVANTAGE?
Comparative advantage is a little bit different. It is measured in terms of the sacrifices each country has to make to produce each item.
In Easterica, to make 1 mango, it costs 2 workers. With the same amount of resources, the country can produce 2 bananas. Therefore the cost of 1 mango is 2 bananas.
In Westasia, to make 1 mango it costs 4 workers. With the same amount of resources, the country can produce 1 banana. Therefore the cost of 1 banana is 1 mango.
Since Westasia has to sacrifice less bananas to make 1 mango, they have the comparative advantage in making mangoes.
A comparative advantage in Westasia for mangoes, means a comparative advantage in Easterica for bananas. You can see that even though a country such as Westasia has to use more resources to make a product than the other country (absolute disadvantage), they can still have a comparative advantage.
Comparative advantage is all about the relative advantages of each country. It does not matter how they operate individually, but how they operate in a world with each other.
WHY IS COMPARATIVE ADVANTAGE SO IMPORTANT?
Comparative advantage is important for trading. The cooperation of two (or more) parties allows both of them to operate, produce a product, and then trade it for other ones. The country produces the product that it has a comparative advantage in, and has the opportunity to trade with countries who have advantages in other products. This means that they sacrifice, less resources, and so do the countries they trade with.
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1 comment

  1. Mohamed Hassan Tahliil 3 years ago April 30, 2018

    I am part for those who read these valuable articles. I am very happy to see such educators who share their education for us. For me I study Accounting at university and what I recommend is that more Accounting must be published soon such as stocks, bonds, difference between corporation and partnership,internal control and so on. Thanks for everyone who is contributing their knowledge as well sharing ideas.

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